Introduction
It is widely recognized that many successful late-developing countries have boasted, and benefited from, a substantial state-owned sector during their rapid growth periods. Amongst the ‘East Asian Tigers’, for instance, Taiwan has had one of the largest public sectors in the developing world outside the oil producers and achieved one of highest growth rates in the post-war period.Footnote 1 Similarly, Korea had a very large state-owned sector with crucial intermediate inputs such as steel, oil, coal, gas, electricity, and fertilizers having been supplied by public enterprises. Singapore's government owns controlling stakes in a host of highly efficient and profitable enterprises called ‘government-linked companies’ which extend to sectors beyond public utilities and infrastructure such as shipbuilding, aviation, engineering, shipping and banking.Footnote 2 Finally, China has refused to close down its state-owned enterprises (SOEs), choosing instead to opt for greater managerial autonomy and larger scale.Footnote 3
These countries have been emulating Western models where SOEs historically played a key role. Post-war growth in many European economies including Austria, Norway, and Italy was achieved with large SOE sectors often being at the forefront of technological modernization, until at least the 1980s. France and Finland are two notable examples. In France, well-known firms such as Renault, Alcatel, Usinor, Thomson, Thales, and Elf Aquitaine led technological modernization and industrial development under state ownership in the areas of automobiles, telecommunications, steel, electronics, defence, and oil and gas.Footnote 4 Similarly, in Finland, SOEs led technological modernization in forestry, mining, steel, transport equipment, paper machinery, and chemical industries.Footnote 5
However, following the 1970s oil shocks and economic crisis in the developed world, the social democratic ‘mixed-economy’ model and Keynesian aggregate demand management was increasingly questioned, ushering in the rise to prominence of monetarist, public choice, and property rights theories, or what has been termed ‘neoliberalism’. An overall change in development thinking amongst international financial institutions (IFIs) and local policy makers was seen, with trade, financial, and labour-market liberalization and deregulation now dominating the agenda. These views were codified in the late 1980s in the now infamous ‘Washington Consensus’.Footnote 6
As part of this wider shift, a spate of privatizations was pushed through. The campaign was particularly noticeable in developing countries, where desperate economic circumstances and dependence on loans from IFIs left little choice but to sell SOEs.Footnote 7 Thus, across many Latin American countries, state assets in sectors ranging from manufacturing, finance, and mining to social services were sold off, with Chile taking the lead, followed by Mexico, Argentina, Bolivia, and Brazil.Footnote 8 In sub-Saharan Africa, although few governments explicitly adopted an SOE divestment strategy, there was still a significant amount of privatization, especially in countries like Mozambique,Footnote 9 Ghana and Nigeria,Footnote 10 while privatization in East Asia lagged behind.Footnote 11 In South Asia, Pakistan and India led the proceedings but, while India generated revenue largely from minority share sales, retaining strategic control, Pakistan handed over strategic control in a wide variety of sectors.Footnote 12
After more than three decades of privatizing SOEs, however, the outcomes have been mixed at best. In fact, much research has shown how privatization has not yielded the expected outcomesFootnote 13 and state-owned enterprises are not detrimental to economic growth.Footnote 14 Still, unvarying privatization advice is continuously dished out by multilateral agencies such as the World Bank and International Monetary Fund (IMF) as a panacea for economies characterized by fiscal crises and underdeveloped markets. Even within developing countries, there appears to be little resistance to it except from labour unions.
This trend is not confined to academic scholarship. At a more popular level, it is interestingly captured in a 2012 issue of The Economist magazine, an unabashed evangelist of free markets. In its 21 January 2012 issue, The Economist magazine wrote:
State capitalism is on the march, overflowing with cash and emboldened by the crisis in the West. State companies make up 80% of the value of the stock market in China, 62% in Russia and 38% in Brazil. They accounted for one-third of the emerging world's foreign direct investment between 2003 and 2010 and an even higher proportion of its most spectacular acquisitions, as well as a growing proportion of the very largest firms.Footnote 15
The magazine went on to declare that state capitalism increasingly looked like ‘the coming trend’. It wrote:
In the 1990s most state-owned companies were little more than government departments in emerging markets; the assumption was that, as the economy matured, the government would close or privatize them. Yet they show no signs of relinquishing the commanding heights, whether in major industries (the world's ten biggest oil-and-gas firms, measured by reserves, are all state-owned) or major markets.Footnote 16
The magazine then goes on to suggest various reasons why, despite their global success, these SOEs might still be bad for national competitiveness because of the way they distort markets. It is this contradiction between advice and evidence that we explore in this article. Specifically, we look into how the welcome mat for privatization continues to be rolled out even when the results are suboptimal. In particular, how does this process take place in developing countries characterized by increasingly neoliberal regulatory environments? We focus particularly on how privatizations are carried out to create rent-seeking regimesFootnote 17 and ponder why there is little resistance.
We illustrate these dynamics in the context of two major privatizations in a South Asian country: Pakistan. Pakistan is an interesting empirical site to learn about ways in which privatization, despite its numerous failures, is still cherished, because it is one of a set of developing countries that have whole-heartedly embraced neoliberalism and extensively implemented Washington Consensus policies. In the 1950s and 1960s, Pakistan was held up as the poster-child for late development and considered on a par with South Korea.Footnote 18 Since then, the two have followed markedly different development trajectories, with Korea surging ahead and Pakistan losing its competitiveness drastically.Footnote 19 Since privatization drives have been a key plank of Pakistan's economic policy, it is pertinent to analyse their antecedents and consequences. Furthermore, Pakistan's experience with mass privatization is generalizable to many other developing countries that have followed ‘Washington Consensus’ policies.Footnote 20
Our cases include privatization of national banks, and introduction of private producers in the energy sector. Using a mix of painstakingly collected primary and secondary data, we analyse the outcomes of these privatizations and analyse why there has not been more questioning of these suboptimal results. Specifically, we describe how the decidedly neoliberal policy regime and regulatory environment have allowed the socialization of losses and the privatization of profits. Our findings shed new light on the way in which privatization of SOEs is implicated in a South Asian country's underdevelopment and the neoliberal environment that provides the rose-tinted lens through which these reforms are viewed.
All carrots and no sticks: private profits, socialized risk
State ownership of corporations
Why should the state own any corporations? After all, at least in theory, private companies operating under a combination of government regulation, tariff control, and/or a subsidy scheme could undertake most of the functions of SOEs.Footnote 21 This combination should be sufficient to ensure the appropriate incentives to control investment and prices. However, in practice, solutions involving regulation and subsidies often prove difficult to manage for developing countries lacking adequate resources and regulatory capacity. Moreover, provision of subsidies requires tax revenue, which many developing countries with weak states find difficult to raise.Footnote 22 Enforcement of complex regulations similarly requires dealing with legal manoeuvring and political lobbying by powerful firms, which are often subsidiaries of well-resourced multinational corporations (MNCs).Footnote 23
The writings of classical development theorists, such as Gerschenkron (1962),Footnote 24 Nurske (1953),Footnote 25 Rosenstien-Rodan (1943),Footnote 26 and Hirschman (1958),Footnote 27 make a case for SOEs involvement during certain stages of development. According to the Gerschenkron hypothesis, for instance, the later a country industrializes, the more government involvement is required, because the state is the only institution with the resources to help overcome the difficulties of late industrialization. The argument is simple: private investors have an inherent bias towards short-term gains, and are especially risk-averse in developing countries. These ‘capital market failures’ mean that the state needs to step in to finance large-scale, capital intensive projects that might be risky, and have long gestation periods, especially in key sectors of the economy, which are expected to initially make losses. This can often be the case in the manufacturing sector, where such market failures are even more acute due to the large scale of investment required and difficulties in technological upgrading, but which historically has been considered necessary for economic development.Footnote 28
The weight of historical evidence is certainly behind such arguments. As mentioned earlier, many successful late developers such as Korea, Taiwan, and Singapore have had a substantial state-owned sector during their rapid growth periods. Rather than inhibiting growth, evidence show that SOEs have played a crucial role in state-led development strategy.Footnote 29 Finally, SOEs have been used to deal with ‘natural monopoly’ situations, as well as equity issues—to make sure that essential services are provided to all citizens. Examples abound of SOEs that have gone on to become global leaders in their industries.Footnote 30
The tide turns
In the 1970s and 1980s, with the oil crisis and economic recession in the United States of America, this trend began to reverse. Liberalization of trade, financial sector, and labour markets was ushered in. Institutions such as the World Bank and global and local policy makers justified and legitimized this shift that came to be known as the ‘Washington Consensus’.Footnote 31 The consensus derived its legitimacy from the collapse of the Soviet Union and the domino effect that followed in Eastern Europe. With Thatcher in the United Kingdom and Reagan in the United States of America, a paradigmatic shift took place away from Keynesian thinking and the free-market mantra was preached with evangelical zeal.
A spate of privatizations followed around the world, in particular Eastern Europe. The privatization campaigns were accompanied by a host of justifications. Some of the prominent ones included improving efficiency in the privatized industries, reducing the fiscal deficit, easing public-sector pay determination by weakening public-sector unions, and widening share ownership.Footnote 32
These privatizations had to typically face a lot of resistance from unions and bureaucracies. While such resistance was quelled, it did little to legitimize privatization as a desired strategy. This was acknowledged by the chief evangelist of privatizations, the World Bank, in its 1995 Bureaucrats in Business ReportFootnote 33 in which it stated that, in order to push these privatizations through, an approach other than direct force needed to be taken.
This approach turned out to be primarily discursive, where privatization was constructed to be an unquestionably desirable strategy whatever the conditions. By the mid-1990s, privatization was presented as an unquestionably beneficial end in itself and a panacea for all sorts of economic problems, including alleviating short-term fiscal problems, improving competition in privatized industries, maximizing domestic private-sector development, increasing domestic ownership of productive assets, and even reducing income inequalities.Footnote 34 It was argued that SOEs contributed to increased deficits and inflation, which reduced economic growth.Footnote 35 Finally, it was claimed that privatization would reduce corruption and bureaucracy, and could even provide a solution to improving social services such as health and education.Footnote 36
The elimination of sticks and proliferation of carrots
The move to present privatization as a panacea was contextualized in a larger rise in neoliberal economic policies, including financial, trade, and labour-market deregulation and liberalization. This often meant a re-presentation of economic history. Thus, India and China's rising competitiveness was entirely attributed by eminent economists to the rise of the private sector (see for example NaughtonFootnote 37 and Bhagwati et al.Footnote 38 ) and the ‘roll-back’ of the state. The broad-based industrialization that took place in both countries prior to liberalization was portrayed not as the foundation on which subsequent progress took place, but as ‘lost years’ where inefficiency and corruption impeded the progress that could have been made.
During the 1950s, 1960s, and 1970s, successful developmental states used a carrot-and-stick policy with business interests.Footnote 39 This almost always involved the creation of rentsFootnote 40 or ‘carrots’ for capitalists by the state, in return for the capitalists performing a certain economic or social function (the ‘stick’) and withdrawal of the carrots if they did not.Footnote 41 For example, in Korea, some ‘carrots’ provided by the state included government guarantees, soft loans, tax breaks, export subsidies, while the corresponding ‘sticks’ included state direction of investment decisions, meeting export quotas and performance standards, and so on.Footnote 42 Strong states that had the ability to enforce this ‘disciplinary mechanism’Footnote 43 on business had the most economic success.
Privatization, in the absence of a state with the capacity to ‘discipline’ business interests, has only created fresh opportunities for private profits, while shifting the bulk of associated risk to the public sector, and therefore to the taxpayer. Carrots have proliferated while sticks have been eliminated. According to Harvey (2007),Footnote 44 the primary aim of privatization in the neoliberal era ‘has been to open up new fields for capital accumulation in domains formerly regarded off-limits to the calculus of profitability’.Footnote 45 Put another way, it seems to have become easier to privatize the profits while socializing the risks.
It is in this context that we seek to examine privatizations in a South Asian country with a state that is widely perceived to be weak. The case of Pakistan allows us to explore how, after the change from a developmentalist economic model to a neoliberal one,Footnote 46 the state is able to privatize profits while socializing the risks. The aim of the study is to see how the socialization of risks and privatization of profits is carried out in the course of privatization, and how the context and discourse facilitate it. The study is important because systematically collected empirical evidence on privatizations in developing countries is rare simply due to the unavailability of information that one takes for granted in developed countries. Indeed, much of the evidence is collected and presented by multilateral agencies that have been the chief proponents of privatization in the first place. We hope that our empirical analysis of two of the most significant privatizations in Pakistan will provide an alternative view that challenges some of the orthodoxies in economic-reform packages and sheds new light on the process by which privatization has enabled private interests to obtain state-sponsored carrots, without receiving any of the associated sticks.
Methods
Research context
Both of our studies of privatization are situated in Pakistan. There are at least two reasons why we think Pakistan provides a fertile empirical site to study the antecedents and consequences of privatization in the developing world. First, given the ‘neoliberalization’ of Pakistan's economy,Footnote 47 it offers an excellent context in which to study the dynamics that facilitate and encourage the privatization of profits and socialization of risk in privatizations. Second, sufficient time has elapsed since the privatization of the two sectors under study to allow us to examine the effects on performance of the firm as well as on the economy.
Data collection and analysis
In this section, we briefly describe how data were collected and analysed for the two studies.
Privatization of the energy sector
Until the mid-1980s, Pakistan's energy needs were met by the Water and Power Development Authority (WAPDA) and Karachi Electric Supply Company (KESC)—the two public-sector organizations responsible for the generation, transmission, and distribution of electricity. Both were faring quite well.Footnote 48 Electricity was produced primarily through hydropower projects, keeping the production cost minimal. Since the costs of production and demand were low, so inevitably were the subsidies in absolute terms.
By the mid-1980s, increasing demand for electricity and WAPDA's inability to keep pace with it began to result in energy shortages and load-shedding. Entering the 1990s, Pakistan was planning to increase its existing generation capacity for power production. However, instead of increasing public investments in energy, the World Bank encouraged the Pakistani government to privatize the sector before increasing capacity. In 1994, Pakistan announced its privatization policy and, since then, many private-sector power projects have been installed. Despite this, however, the country faces chronic shortages and increasing tariffs.
The first author started investigating this case in collaboration with a highly experienced professional who had managed power projects in Pakistan and other countries. He had been involved in some of these privatization deals as an investment banker as well. Our examination of this case soon took us to a variety of stakeholders including senior figures in WAPDA, the National Transmission and Dispatch Company (NTDC), distribution companies (DISCOS), and various bankers who had been involved in structuring the deals. Much information was also gleaned from secondary sources, including reports published by various aid agencies, multilateral agencies, and the government. Early empirical findings were published with another collaborator and comments on those helped us to refine our analysis further.
Privatization of the banking sector
Until the 1980s, Pakistan had a typically ‘repressed’ financial system, with a system of credit planning, lending targets, directed credit schemes, and regulated interest rates. Development Finance Institutions (DFIs) and specialized banks existed to provide the bulk of long-term credit and credit to neglected sectors, while five large nationalized commercial banks (NCBs) played a supporting role, providing mainly trade and working capital finance.Footnote 49 Financial liberalization and deregulation began in earnest in 1988 under the IMF's structural adjustment programme. Gradually, all major nationalized banks were privatized, with only the National Bank of Pakistan (NBP) left in the public sector.Footnote 50
We set out to examine how the role of the banking sector in the economy changed after privatization. This involved utilizing both firm-level and macroeconomic data, as well as 33 semi-structured interviews with policy makers, regulators, senior- and junior-level private bank employees, and ex-DFI employees. The interviews were used to triangulate our findings, as well as to shed light on causality in some cases. While previous studies on bank privatization usually compare the firm-level performance of public versus private banks in terms of profitability, efficiency, and capital adequacy ratios, we use different assessment criteria. Given that the function of the national financial system is to provide credit, at adequate levels and prices, to the relevant sectors of the economy, rather than to create profits for a small number of shareholders, firm-level performance according to shareholder criteria is, at best, of secondary importance when assessing the banking sector's contribution to the economy. Therefore, we compare the behaviour of the five largest privatized commercial banks pre and post privatization in relation to their effect on the wider economy, in terms of their loan maturity, the sectorial distribution of their lending, and their cost to the taxpayer.
The historical firm-level data (from 1972 to 1996) were collected from company accounts in the State Bank of Pakistan (SBP) archives, where it was only available in hardcopy. From 1996 onwards, data were more easily available on the SBP and company websites. Various financial ratios were calculated and analysed using these data. Any anomalies in the data were understood using the relevant notes from the company accounts and SBP annual reports from the relevant time periods. Macroeconomic or aggregate bank-level data all come either from the SBP, in some cases from their publicly available online database and in others through contacts at the SBP; from the World Bank Development Indicators; or from the Pakistan Economy Survey. Parts of our analysis appeared in the Economic and Political Weekly and were circulated widely to policy makers and bankers, who personally agreed with our analysis, if not with our implied policy conclusions.
Findings: privatization of energy and banking
The ‘neoliberalization’ of Pakistan
Before we delve into the two particular cases of privatization, it is important to note the sea change that came about in Pakistan in the late 1980s and early 1990s. As mentioned above, following the fall of the Berlin wall and disintegration of the Soviet Union, free-market policies swept across the globe. Pakistan was no exception. Its dependency on the IMF further acted as a catalyst in this process, with the IMF's structural adjustment programme (SAP) enforcing dramatic changes in various parts of the economy.Footnote 51 Around 1989, Pakistan started on a road that led to reductions in public expenditure, more open trade, liberalization of the economy, and privatization.Footnote 52
The free-market paradigm, which did not allow for any state interference in trade or domestic industry, and which was actively pushed by multilateral agencies, gradually came to be entrenched in Pakistan. Both academic and policy-making circles soon came to reflect this new consensus. The ascendancy of neoliberal thinking in Pakistan's policies becomes clearly visible if one takes a look at the changes in key positions in government. In the central bank, the State Bank of Pakistan (SBP), between 1947 and the late 1970s, the first six governors had had domestic banking or civil service backgrounds. The next five governors had loose affiliations with the IFIs, such as holdings in consultancy assignments or attending training courses. From 1993 to 2009, however, the next three appointees—Muhammad Yaqub, Ishrat Hussain, and Shamshad Akhtar—had previously made their careers in the IMF, World Bank, and Asian Development Bank, respectively, showing a clear pattern. This was followed by the appointment of international investment bankers as governors. An examination of the backgrounds of finance ministers reveals similar trends. Before the 1980s, finance ministers tended to be domestically educated career civil servants or lawyers. From the 1990s onwards, several ministers were appointed with World Bank or Citibank backgrounds, including Citibanker Shaukat Aziz, who went on to become prime minister.
This transformation of the policy regime had already started when privatizations began in Pakistan in the early 1990s, and was further consolidated throughout the 2000s. This essentially meant that privatization was coming to be seen as an end in itself rather than a means to an end. This becomes clear from how the two privatizations that we describe were conceived, carried out, and evaluated. Below, we detail our findings in the two cases of privatization.
Privatization of the energy sector
Pretext for privatization
With encouragement and financing from the World Bank, Pakistan took the first step towards privatizing its energy sector in 1985.Footnote 53 A committee was formed by the Economic Coordination Committee of the Cabinet (ECC) in July 1985, which strongly recommended private-sector involvement in expanding energy capacity as a solution to the ongoing energy shortages. It was explicitly stated in their report that power generation was seen as a convenient area for private-sector participation, in order to further the broader agenda of increasing the role of the private sector and decreasing that of the public sector in the economy.Footnote 54
In the years that followed, a number of influential reports by transnational organizations, such as the World Bank and USAID, contributed to further portraying WAPDA and KESC as inherently inefficient, poorly managed, and overly complex SOEs. According to the 2010 Poverty Reduction Strategy Paper (PRSP), these public-sector oligopolies were ‘large, monolithic, vertically integrated utilities with overstaffing, financial and technical inefficiencies, and a lack of competitive spirit’.Footnote 55 According to an article in the Dawn newspaper in 2002, WAPDA and KESC ‘continue to bleed financially despite regular pumping of billions of rupees into them by successive governments’.Footnote 56 The public sector was portrayed as inherently unable to carry out infrastructure development on the required scale due to resource constraints, lack of sufficient institutional capacity, and lack of technical expertise.Footnote 57 Specifically, it was argued that the current generation and provision mechanism was marred with inefficiencies and corruption, which necessitated provision of subsidies in order to make power affordable to consumers. Privatization would (i) lead to better, wider, more reliable service delivery and (ii) free up government resources to spend on health and education. It was also argued that cutting subsidies would be good because they were not helping the poor anyway, as they were mostly not connected to the grid.Footnote 58 Finally, the involvement of private-sector independent power providers (IPPs) was also justified on the basis that this would boost ‘competition for and in the market for electricity supply’.Footnote 59 Government guarantees for these IPPs were justified as necessary to ‘help to gradually develop competition in the power sector by creating the necessary environment for attracting investment’.Footnote 60
The privatization process
Pakistan's privatization experiment with the energy sector began with the new 1994 Power Policy. The terms on which investors were invited to set up generation capacity in the country were some of the most generous in the world. Structurally, it was built on a cost-plus-returnFootnote 61 basis in US dollar terms. Investors were to be provided a US dollar-based internal rate of return of 15–18 per cent per year over the 25- to 30-year period of the power purchase agreement after covering for operational costs. This was further backed by sovereign guarantees from the government of Pakistan. The Independent Power Producers (IPPs) were to be paid every month in two parts, namely a ‘capacity payment’ and an ‘energy payment’. The ‘capacity payment’ reimbursed the IPP for all the fixed costs of the power plant, including debt servicing (which, at an allowance of 80:20 debt-equity ratio, proved to be very high) and provided the investor's equity return on top. These payments were to be made irrespective of whether or not the IPP was asked to produce electricity. The ‘energy payment’ reimbursed the IPP for all variable costs of production, such as fuel costs, regardless of the type of fuel employed and its market price. All payments were indexed (if relevant) to the USD/PKR exchange rate and inflation (local or foreign) changes.
Furthermore, IPPs were exempted from corporate income tax, customs duties, sales tax, and other surcharges on imported equipment. Permission was also granted for power-generation companies to issue corporate bonds and shares at discounted prices (Fraser, 2005). It was no surprise that the then United States Secretary of Energy, Hazel O'Leary, described it as ‘the best energy policy in the whole world’.Footnote 62
Three things were noticeable about this policy. First, though it offered highly generous returns, it provided no incentives to make the plant design efficient. In fact, since the government paid for all operational costs, many thermal IPPs understated their efficiency. Second, the policy was fuel blind, which meant investors were free to set up furnace oil-based thermal IPPs (the most expensive fuel option) with the government still covering the cost of the fuel. Finally, with the government guaranteeing returns to investors, there was effectively no competition in the market, again engendering inefficiency. How this policy got adopted was explained by a leading banker involved in the deal: ‘We had been trying for years but the WAPDA people and bureaucrats had been resisting us. Then the World Bank leaned on the government, basically telling them that any loans would be conditional on privatization. That's how we got moving again.’Footnote 63
Outcome
The outcome of the privatization policy was perhaps predictable. The highly generous deals that the government offered to investors meant that, for every hypothetical but typical 100 MW thermal (oil-fired) power plant in the private sector, the government would end up spending US $21.42 million more than it would in the public sector over the life of the power project (for a detailed analysis, see Munir and KhalidFootnote 64 ). With most of the investors setting up thermal units, the country became hostage to rising oil prices—this led to massive debts that had to be cleared through more borrowing.
A longer-term and highly damaging consequence of the private power policy was the fuel mix it engendered. In the 1980s, the country's electricity generation relied on a fuel mix of approximately 60:40 in favour of hydropower versus thermal. This changed dramatically over the next decade, with the fuel mix going to 30 per cent hydropower and almost 70 per cent thermal by the end of 2010.
As Munir and Khalid (2012) show, contrary to claims of inefficiency in the public-sector power plants, the average blended cost of public-sector plants was actually lower than the IPPs. Unfortunately, as a result of the policy, 52 per cent of power came to be purchased by the government from IPPs (supplying at a higher cost). The downstream effect of shortages and higher tariffs was significant. By 2011, industrial output was down by up to 37 per cent,Footnote 65 with numerous factories and businesses closing down due to shortages and the excessive cost of deploying small generators.
Privatization of major banks
Pretext for privatization
In the late 1980s, the pre-reform financial system in Pakistan came under criticism by both domestic policy makers and IFIs (see for example Hussain,Footnote 66 State Bank of Pakistan,Footnote 67 and Ul HaqueFootnote 68 ) for a number of reasons. These included crowding out of the private sector, causing a large budget deficit, low bank profitability and efficiency, a high degree of concentration in the banking sector, inadequate provision of credit to small and medium enterprises, and ‘political lending’ leading to a high number of non-performing loans. Some of these criticisms were justifiable, especially those related to concentration and SME lending; however, on the whole, the financial sector was functional, providing adequate amounts of credit to key sectors such as manufacturing and agriculture at reasonable cost.Footnote 69
In line with the overall policy direction, privatization of banks was recommended as a remedy for all of these problems. It was argued, amongst other things, that privatization would lead to greater competition in the banking sector, improve firm-level performance, and improve savings mobilization.Footnote 70 Following privatization and the dismantlement of interest rate controls and credit ceilings, greater bank-level efficiency and profitability would not only be a good in and of itself, but also improve the governments’ fiscal position. It was argued that this would free up resources for spending on physical and social infrastructure.Footnote 71
Apart from this, according to interviews with senior SBP officials and ex officials, it was argued that private banks would reduce ‘political lending’ and as a result non-performing loans (NPLs) would decrease, leading to a better risk assessment and more optimal allocation of resources. Furthermore, it was argued that private investment would increase as the public sector withdrew, reducing ‘crowding out’. The nationalized commercial banks (NCBs) had to hold 30 per cent of their portfolio in government debt at a fixed, low interest rate. According to a retired senior SBP official, it was argued that, if these controls were lifted, the banks would reduce their holdings of government debt, which were making them unprofitable, and instead increase lending to the real economy and especially to neglected sectors such as agriculture and SMEs.
The privatization process
The privatizations began with the sale of Muslim Commercial Bank (MCB), which was sold for Rs 2.4 billion (US$ 97 millionFootnote 72 ) in 1991 to a group led by industrialist Mian Mansha, a close ally of then Prime Minister Nawaz Sharif. That this was a ‘fire sale’ was evident from the fact that, only after a few years, MCBs profits were higher than its sale price.Footnote 73 Next came the privatization of Allied Bank Limited (ABL), sold first in 1991 to the Employees Management group and, after going into negative equity and being renationalized, resold to a private group for Rs 11 billion (US$ 185 million) in 2004.Footnote 74
Next, 51 per cent of United Bank Limited (UBL)’s shares were sold in 2002 to a consortium of foreign investors including United Kingdom-based cash-and-carry chain Bestway and the Abu Dhabi group, a United Arab Emirates (UAE) private equity fund. Rather than generating a windfall for the government, the sale resulted in a net drain of Rs 8.65 billion (US$ 148 million)—even though the bank was sold at Rs 12.35 billion (US$ 212 million), the government had previously injected Rs 21 billion (US$ 360 million) in equity in order to improve its performance in preparation for sale. Furthermore, the bidding process was not transparent, as parties were allowed to raise their bids after the initial round.Footnote 75
UBL's privatization was followed by that of the country's largest bank, Habib Bank Limited (HBL). HBL was sold in 2003 for Rs 22.4 billion (US$ 390 million), after giving it an equity injection of Rs 18 billion (US$ 313 million). Moreover, benefits worth Rs 18.84 billion (US$ 320 million), including income-tax refunds and a transfer of bad debts to the government-owned Corporate and Industrial Restructuring Corporation (CIRC), were announced after three bidders had already been shortlisted, violating the auction rules.Footnote 76 In effect, the oldest, largest, and most established Pakistani bank—which accounted for over 20 per cent of Pakistan's total banking operations and boasted an extensive international network of branches in 26 different countries—was privatized at a loss of Rs 14.44 billion (US$ 251 million).Footnote 77 To top it off, it was given to the Agha Khan Fund, a non-corporate entity with no expertise in banking.
Outcome
The few empirical studies that have been done on bank efficiency pre and post privatization show no clear improvement in efficiency.Footnote 78 However, as shown by Munir and Naqvi (2013),Footnote 79 bank profitability increased dramatically post privatization even when overall economic growth was sluggish.
As Munir and Naqvi (2013) point out, a closer look at the sources of bank profitability reveals that this increase came at the expense of the real economy. An examination of the data on net interest margins for the large five banks shows that profitability coincided with an increase in interest rate spreads following interest rate deregulation—a factor independent from bank efficiency or risk assessment. Lending rates doubled for the big five banks from 7 per cent to 14 per cent between 2004 and 2007. Deposit rates, however, remained low, with the interest rate spread (difference in lending and deposit rates) in Pakistan between 2004 and 2010 averaging over 6 per cent compared to 2 per cent in Korea and 3 per cent in Malaysia for the same period.Footnote 80
Despite high lending interest rates, banks made such large profits not through increased lending to the real economy based on improved risk-assessment ability as had been predicted, but through dramatically increasing their investment in high-yielding government debt. This was confirmed during interviews with three separate high-level policy makers at the SBP in charge of regulating the banking system. This is all the more ironic given that one of the reasons for privatization was that it would reduce bank holdings of government debt. Whereas in the pre-reform system, NCBs had to hold 30 per cent of their assets in government bonds at a low fixed rates of 4–6 per cent,Footnote 81 long after privatization, the same banks held even more government paper, only at much higher interest rates of about 12–13 per cent. The SBP noted that, at the end of 2012, the share of government securities in total investments of the banking sector was 88.7 per cent.Footnote 82
According to the CEO of one privatized commercial bank, in April 2012, ‘the Treasury Department [which deals with investment in government securities] is currently the most active department in the whole bank, and this is not a good thing [for the Pakistani economy]’. Interviews with privatized commercial bank (PCB) senior employees indicated that high investment in government bonds were justified as a result of a ‘lack of demand for corporate loans’ from firms, due to the general post-2007 economic downturn, as well as the negative economic impact of the energy crisis. For example, one PCB CEO noted that the rationale behind such high levels of investment in government securities was that ‘due to the lack of other investment opportunities, we have lots of excess cash. The risk for the bank is exactly the same if we hold cash, or T-bills, so it makes sense to hold T-bills which give a much higher return’.
Given the unproductive investments made by banks, it is unsurprising that post-privatization lending fell dramatically to its lowest level since 1963.Footnote 83 As of 2014, Pakistan's financial institutions only provided 49 per cent of domestic credit (up from a low of 42.7 per cent in 2011), compared to 143 per cent in Malaysia, 110 per cent in Brazil, and 163 per cent in China.Footnote 84 What little lending there was took the form of working capital or trade finance, rather than long-term finance for investment in improving productive capacity.Footnote 85 According to figures released by the SBP, out of the total amount of lending as of May 2015, about 61 per cent is extended for short-term working capital or trade finance, and only 1.5 per cent for long-term investment finance, with the rest going towards small loans or lending for the purpose of purchasing and discounting bills.Footnote 86 According to a senior PCB executive, ‘there is very little long term finance available because no bank is willing to take the risk in this environment’.
Furthermore, the sectorial distribution of credit also worsened, with agricultural lending falling as a percentage of gross domestic product (GDP). Lending to manufacturing, which is vital for industrial development and had been at almost 50 per cent of total lending in the 1970s,Footnote 87 declined as well, with the exception of a brief spike in lending to textiles, which resulted in many NPLs.Footnote 88 The financial-sector reforms did not do much to improve competition either, despite this being one of their major stated aims. The banking sector still remained highly concentrated, with the five largest commercial banks accounting for 60 per cent of deposits and 80 per cent of profits in the banking sector at the end of 2012.Footnote 89 Lack of competition was exemplified by the fact that, rather than raising deposit rates to compete for customer deposits, the large five banks were able to keep them low, earning high spreads.Footnote 90 According to a senior SBP policymaker, the SBP had to partially reverse liberalization reforms due to PCBs’ ‘ridiculously low’ deposit rates, and impose a deposit floor of 5 per cent in 2008. Discussions with senior SBP policymakers also suggest that the five large commercial banks were able to form a ‘cartel’ to squeeze government during auctions in order to keep yields high, as they were the primary dealers.
Discussion: privatization of profits and socialization of losses
In both the cases described above, it is clear that privatization was carried out in a way that led to the privatization of profits but socialization of losses. Particular interests were advanced in the name of universal ones, and carrots extended without corresponding sticks. The case of energy is straightforward. A rent-seeking regime was set up in the name of privatization. All risk remained with the taxpayer while lucrative returns were guaranteed to the investors. Given that most of the new capacity was furnace oil-based, and oil prices went from US$ 20 to US$ 120 in this period, the government had to keep buying power from private producers at higher and higher prices. This expense was passed on to the consumer through higher tariffs and taxes (imposed on various goods to generate revenue to pay). Ordinary citizens also paid indirectly when rampant energy shortages caused by the state's inability to buy expensive power from the IPPs became one of the major drags on economic growth.
The case of banking was similar. The interest banks charge borrowers is supposed to be a reward for the risk the bank takes in case of possible defaults, while a bank's profits are justified on account of the risks banks take in selecting good projects to which to lend. In the case of the PCBs, it is clear that the shareholders of privatized banks (including foreign investors) were profiting from investment in risk-free government bonds, rather than through making risky investments in the real economy.
While one of the main arguments for privatization and liberalization was that reforms would reduce the government's fiscal burden, by providing ‘market discipline’, the data indicate that the reforms have contributed to just the opposite.Footnote 91 As a result of the government shifting to market-based borrowing in the 1990s, as part of the process of interest rate liberalization and bond market development, yields on government securities increased dramatically, as mentioned earlier. While high interest rates made banks profitable, they also contributed to bringing the government further and further into debt. The government became trapped in a vicious circle post 2007, where it borrowed from the commercial banks in order to fund interest payments, which went back mainly to the commercial banks themselves (commercial banks owned 70 per cent of government securities at the end of 2014, while domestic interest payments made up 92 per cent of all interest payments).Footnote 92 The government was stuck in a vicious circle, where it was now forced to borrow from the commercial banks in order to fund its interest payments, which went back to the commercial banks themselves. As debt service was prioritized over other expenditures by policymakers and IFIs, state capacity to undertake long-term public investment and spending on social and physical infrastructure suffered. The ultimate loser was the taxpayer, who not only funded banks’ profits, but lost out on the economic advantages banks were supposed to bring in exchange.
Apart from direct costs, indirect ones were also inflicted on taxpayers through power shortages and drying up of credit. The World Bank Investment Climate Survey (2007) listed electricity as the most serious perceived constraint, followed by macroeconomic and political instability.Footnote 93 The Global Competitiveness Report 2014/15 ranked Pakistan at 133 out of 144 in terms of quality of electricity supply, even below its overall infrastructure rank of 113.Footnote 94 About 95 per cent of manufacturing firms reported power outages and figures for financial losses due to outages almost doubled between 2002 and 2007.Footnote 95 A high percentage of firms were forced to rely on privately owned, oil-based generators, though the unit cost of power from a generator was much higher than that from the public grid.Footnote 96
In contrast, during the same period, the governments of countries like India and China were drawing their power from coal (which comprised about 70 per cent and 60 per cent of coal in the energy mix, respectively). Pakistan, on the other hand, was using only 6.5 per cent coal (despite possessing one of the largest reserves of coal in the world), relying heavily on oil instead.Footnote 97
Privatizing the major banks dried up the long-term finance needed for the upgrading of the productive structure. Historically, countries that have developed rapidly, including Korea, Taiwan, China, and Brazil, have mobilized their financial sectors to service development by directing them to provide large amounts of credit for those sectors deemed important for long-term economic development. The post-privatization financial sector in Pakistan played exactly the opposite role. The inability of the financial sector in Pakistan to provide credit to the productive sectors of the economy, while diverting resources instead to unproductive investments in government bonds and consumer finance, posed a severe constraint on economic development. The 2013 Investment Climate Survey shows that Pakistani manufacturing firms finance 86.5 per cent of investment through retained earnings, and only 2.4 per cent through banks—far lower than the regional average of 20 per cent.Footnote 98 Interviews conducted with industrialists, policy makers, and bank officials unanimously suggest that the situation has become especially dire after the bursting of the post-9/11 bubble in 2008. According to the owner of a large industrial conglomerate, ‘Even for me it is difficult to get a loan, the banks are only giving loans to large blue chips [companies] that are already customers, or to the military’.
On the whole, industrial growth was much higher in the 1970s and 1980s than it has been in the post-reform era, even during the boom period of 2001–08.Footnote 99 Although GDP growth in Pakistan has been comparable with other developing countries, investment in the manufacturing sector has been low in comparison.Footnote 100 High energy costs and lack of availability of finance led to a lack of industrial investment, which contributed to the stagnation of manufacturing, the erosion of Pakistan's heavy industrial base, and a decline in export competitiveness after the 1980s.Footnote 101 Pakistan's share of manufacturing in GDP now pales in comparison to the Newly Industrialized Asian countries (South Korea, Taiwan, Malaysia, and Indonesia), which started industrialization in the same time period (1960s) as Pakistan.Footnote 102 Manufacturing growth rates have fallen to an all-time low in the post-2007 period, at about 2 per cent per year.Footnote 103
Evaluating privatization in the land of believers
But all this is not what the privatizations were evaluated on. In both cases, any opposition at the intellectual or policy level was conspicuous by its absence. To be sure, there were numerous popular protests against privatization, especially from unionized workers in both the public banks and utilities companies. Public employees accused the banks of sacking thousands of lower-ranking workers, while hiring highly paid senior management (often from foreign banks) at the same time.Footnote 104 In the case of energy, public-sector utilities workers expressed their anger during various protests, demanding that privatization be cancelled, trade union activities be restored, and contractual employees be given permanent contracts.Footnote 105 According to the protestors, privatization was being pushed through by the IFIs, but was against the interests of low-income Pakistanis, as it would result in a rise in the price of basic utilities and the loss of thousands of jobs.Footnote 106 However, although they sometimes caused delays, these popular protests were ultimately not strong enough to halt the tide of privatizations, and privatization had the effect of further weakening the labour movement between the 1990s and 2000s.Footnote 107
In spite of opposition by the unions, banking-sector privatization was presented as a resounding success. The IFIs were unanimous in their praise for Pakistan's banking sector's successful transformation. In Ishrat Hussain's 2004 report on the banking sector for the World Bank and IMF, the banking reforms were hailed as a success that was ‘very rare among developing countries’.Footnote 108 The IMF claimed that ‘An important achievement in the last decade has been the transformation of a largely state-owned and weak banking system into a healthier, primarily privately-owned system’.Footnote 109 According to the 2010 PRSP, the Pakistani banking sector was regarded as ‘one of the fastest growing and best performing sectors in the region’ which has made it into ‘one of the top three destinations [within Pakistan] for foreign investment inflows’.Footnote 110 Despite all evidence to the contrary, former Prime Minister Shaukat Aziz repeatedly described the post-reform banking sector as a ‘vibrant private sector industry’ and an ‘engine of growth for the economy’.Footnote 111 According to recent press releases by the SBP, the performance of the banking system sector ‘remains impressive’, based mainly on profitability indicators and capital adequacy ratios.Footnote 112
The IMF's assessment of the post-reform situation seemed to be completely out of touch with reality. The 2010 PRSP's assessment of the situation when lack of long-term finance was at its peak was that ‘ongoing financial sector transformation has helped in meeting the growing financing requirements of the productive sectors, while generating consumption demand through increase in consumer financing that. . . provided a major stimulus to real sector growth in the country’.Footnote 113 According to a 2014 assessment by the IMF, credit growth from a ‘healthy financial sector’ reflects ‘declining SBP fiscal financing, easing structural bottlenecks, and NFA growth’.Footnote 114 Blatantly ignoring the government's fiscal burden caused by interest payments to commercial banks, the 2010 PRSP states that, while the pre-reform system was intermediating savings ‘primarily to fund the fiscal deficit and the losses of the public sector’, the ‘continuous restructuring [of state-owned banks] has reduced the burden on the government and has left few minor areas to concentrate’.Footnote 115
The reigning supremacy of a neoliberal logic and the appointment of free-market economists to important policy-making positions means the evaluations are heavily biased. There is a complete refusal to accept that privatizations could have suboptimal outcomes. In fact, the most prevalent line of criticism against the financial system is that it is not liberalized enough. The government (encouraged by the IMF) believes that, in order to ‘sustain a high rate of economic growth, a second generation of [liberalization] reforms will be needed’.Footnote 116 Comparisons with other late developers are studiously avoided. Thus, the underdevelopment of the capital markets is uncritically presented as a major problem without considering that most of today's successful late developers, including Korea, developed without any kind of stock or bond markets, not to mention the many well-known risks and negatives associated with capital market development. Rather than institute reforms which force the banking system to make productive long-term investments, measures such as development of the institutional investor base, including mutual and private pension funds, and the introduction of complex new financial products such as index futures contracts, are made a priority.Footnote 117
Conveniently, rather than assessing privatization according to its initial aims, success was measured merely by the speed of privatization reforms themselves, the high level of bank profitability, and firm-level risk and efficiency indicators. Forgotten is the fact that the function of a banking system is to channel financial resources to those areas most productive for economic development, not purely to make high profits for private shareholders. Similarly disregarded was the initial hope that bank profitability would both reduce the government debt and increase competition—neither of which has been the case.
The case of energy was similar. Despite continued protests over rampant load-sheddingFootnote 118 and tariff increases,Footnote 119 policymakers remained visibly wary of questioning the policy framework that produced these conditions. By the late 1990s, the worsening of the energy situation was explained away by local policymakers and IFIs as a result of privatization reforms not being implemented quickly enough. For example, in a 1998 Policy Framework Paper prepared by Pakistani authorities in collaboration with the IMF and World Bank Staff, although problems in the energy sector are presented as one of the key structural issues facing Pakistan, the blame is placed on the slow pace of privatization of public-sector utilities WAPDA and KESC.Footnote 120 According to this report, the poor condition of public utilities is purely the result of ‘deteriorating operational efficiency’ and slow implementation of pricing reforms aimed at removing subsidies to households and agricultural tube wells. The government's medium-term plan to address these problems was based around ‘accelerating the reform programs in order to achieve efficiency improvements in the medium term’, which includes ‘completing the corporatization process’ by establishing new commercially oriented power producers, implementing theft-reduction programmes and intensifying bill collection, and raising tariffs to ‘restore financial viability’.Footnote 121
In the 2004 Poverty Reduction Strategy Paper (PRSP), difficulties in the energy sector are blamed on the ‘global downturn in the power sector’.Footnote 122 By 2010, the PRSP was forced to note the, by then, severe energy crisis, but once again stopped short of questioning the policy framework that led to it. Despite the crisis, the Pakistani energy sector was praised on the basis that it ‘has one of the most advanced Public Private Partnership programs in the power sector . . .. It has also gradually expanded the scope of this program . . . the response of the private sector continues to be positive’.Footnote 123 Major news agencies also saw the main problem as the continued presence of public-sector utilities. According to an article in the Business Recorder, ‘certain monopolies must be broken to get out of the power sector mess . . . K-ElectricFootnote 124 is a present day success story, why not replicate it?’.Footnote 125
The questionable outcomes of privatization and the policies leading to them were never questioned, reflecting a consensus at the top. While labour unions and the occasional progressive civil society group put up some resistance, Op-eds in major newspapers and the overall policy discourse were almost unanimously behind privatization. Economists heading important policy institutions ranging from the ostensibly autonomous State Bank to the Planning Commission never challenged the arguments presented by the government in favour of privatization.
In short, neoliberalism is not just marked by policy and ideology favouring the private over the public sector, but this has been institutionalized within government capacity itself and the commercial pressures to which it responds.Footnote 126 This institutionalization takes a number of forms at global, regional, and national levels. At the global level, the key role is played by the IMF and the World Bank, and especially the World Bank's arm dedicated to financing the private sector, the IFC. At the regional level, the Asian Development Bank has been pushing this agenda and, finally, at the national level, the various people appointed to important positions in the government and economic institutions have been zealously pursuing this course.
Conclusion
We show clearly in this article how privatization in these cases has not only not lived up to its multiple claims, including but not limited to reducing the government deficit, improving competition and firm efficiency, improving the allocation of resources, reducing corruption, and leading to increased overall economic growth, but has in fact made matters worse in almost all of these aspects. The outcome has been neither economic efficiency nor improved services to the taxpayer, but simply the privatization of profits and socialization of losses. Resources or ‘rents’ have been transferred from the public purse—which could redistribute it to even out social inequalities—to selected private hands. While such rents have historically played a part in economic development, in the case of Pakistan, they have not been accompanied by the corresponding ‘disciplinary mechanism’, which forced business interests to carry out their developmental functions in successful developers such as the East Asian Tigers.
What has enabled all this to go unchallenged and largely unscrutinized is the hegemony of the neoliberal paradigm in Pakistan. ‘Neoliberalization’ has swept across the world and Pakistan has not been immune to it. While privatization of public assets has been a prominent feature of the neoliberal project everywhere, in some countries, such as Brazil or India, strong traditions of nationalism or socialist currents have tempered the neoliberal turn. In Pakistan, on the other hand, the hegemony of neoliberal thought appears complete amongst intellectuals and policymakers. It is of course always difficult to prove the absence of something but, from what we could tell from our extensive search, there was a distinct lack of debate around privatization in Pakistan. The dominant discourse among policy makers showed a zealous commitment to the private sector, even when competitive forces were absent, and a state strong enough to regulate economic activity missing. The private sector's superiority was deemed to be inherent, and private enterprises above all suspicion, while SOEs were seen to be inefficient, corrupt, and market distorting. This is not to imply that SOEs are a good in and of themselves; public ownership can, and has, served elite and corporate needs, while marginalizing the poor.Footnote 127 Indeed, public banks and energy companies in Pakistan suffered from real problems, as detailed above. Our argument, however, is that uncritical and blanket privatization is not the solution.
In short, while the neoliberal project has facilitated privatization, the complete entrenchment of this paradigm has created a situation in which privatization has come to be seen as an end in itself. While even economics textbooks describe specific conditions under which privatization may be the way forward, in Pakistan, any constraints have now been discarded. If the belief in markets is sufficiently firm, privatizations become the only alternative, superior to the public sector under all conditions. It is this transformation that we have sought to highlight in this article. We hope that our analysis, based on primary data, of the two privatizations and the description of the entrenchment of a neoliberal paradigm in Pakistan will lead to further explorations of this transformation at both macro and micro levels.
